Estimates of Fundamental Equilibrium Exchange Rates, May 2012

Cline and Williamson calculate a new set of fundamental equilibrium exchange rates (FEERs) based on the new round of International Monetary Fund (IMF) projections in the spring 2012 World Economic Outlook. These show that on a trade-weighted basis the US dollar is now overvalued by 3–4 percent, while the Chinese renminbi is undervalued 3–4 percent. Both misalignments are much lower than in previous years (6 percent overvaluation and 16 percent undervaluation respectively a year ago). Because of the large roles of China and the United States in global imbalances, the GDP-weighted absolute value of divergence from FEERs has fallen from 8.4 percent in 2009 to 2.6 percentage points in April 2012. In contrast, large imbalances and misalignments have persisted in a number of smaller economies, including Australia, New Zealand, South Africa, and Turkey on the deficit side and Hong Kong, Malaysia, Singapore, Sweden, Switzerland, and Taiwan on the surplus side.

While the world has probably made genuine progress in groping its way to more realistic exchange rate relationships, in particular through the 30 percent odd real revaluation of the renminbi since 2005 (40 percent real bilaterally against the dollar), the measurement of this progress is also influenced by the fact that in 2012 the IMF has revised downward its estimate of the size of the Chinese surplus in the out-years. But China remains a country with fast productivity growth in its tradable-goods sector, and accordingly there will be a continuing need for China to maintain appreciation in the future. Moreover, it is conceivable that the IMF has overadjusted for its past overestimates of China’s prospective surpluses and that the needed exchange rate changes are in fact larger than the current Cline-Williamson estimates. Apart from the imbalance centered on the United States and China, there is a second major problem with real exchange rates today: the overvaluation of the European periphery in terms of German costs. Despite the unavailability of depreciation as a corrective mechanism within the single currency, substantial reductions in current account deficits have been achieved since 2010 in Italy, Spain, and especially Portugal, but in Greece the deficit remains large.